COMMENT: Does timing of Demonetisation make it a political move?

Shishir AsthanaMoneycontrol Research

It is early days to assess the impact and utility of demonetisation on the economy. Everyone from economists to the common man on the road has a point of view on the subject. While no final decision can be taken on demonetisation without data on value of banknotes returned, tax collected and increase in tax net, let’s spare a thought to the timing of the whole exercise.

Could the note ban have been called earlier rather than on the eve of important state elections which has made it look like a political move? Or could it have been delayed as the economy was picking up?

Recently released data from the Reserve Bank of India (RBI) on the performance of listed non-government and non-financials shed light on companies whose sales increased by 1.9 percent for September 2016 quarter. Despite the average turnover, the aggregate net profit increased by 16 percent, thanks mainly to a drop in interest costs.

A closer look at the numbers reveal that the manufacturing sector had picked up and grew by 3.7 percent in sales, 10.4 percent at the operating profit level and 27.5 percent at the net profit level. The IT sector, on account of a depressed global scenario, posted a 7.2 percent topline growth but pricing and currency pressure resulted in operating profits increasing by only 2.2 percent and net profit by 4.8 percent only.

However, the non-IT services sector had seen a 3.5 percent drop in revenues, but a 4.3 percent growth in operating profit was not enough to prevent a slide in its net profit which fell by 3.7 percent.

Given this data was demonetisation done at the right time especially since manufacturing was showing signs of growth?

Digging in further, data reveals that only 464 companies out of the total 2702 companies vetted by RBI, contributed to the sales surge of over Rs 1,000 crore. Further, only companies with sales of over Rs 500 crore were profitable on an aggregate level in the quarter ending September 2016.

September 2016 was the first quarter on the present data analysed by the RBI which showed that revenue and profits of the top companies showed signs of growth. Normally, it is the top companies who are first off the block in a rising economy. These, in turn, transmit growth to the smaller companies often with a lag.

Given these data points it is clear that just before demonetisation was announced on November 8, companies with revenues over Rs 1,000 crore were at an inflection point.

Demonetisation has impacted the struggling smaller companies more than the larger ones. The services non-IT sector, especially real estate, which was already under pressure, was crushed due to demonetisation.

The question now is do these sectors have enough muscle power left to pull themselves up and provide growth to the economy.

The bigger companies, which have both domestic and international presence, and who weren’t leveraged too badly, will be the clear winners going forward. The organised sector will gain as demonetisation was meant to be a frontal attack on the unorganised players. The unorganised players who mainly survived on tax arbitrage will now find themselves paying higher taxes, either on account of demonetisation or GST. Organized players will clearly have a lead over them.

Smaller players --- those with less than Rs 1,000 crore in sales -- were mainly suppliers to larger companies. However, their balance sheet was stretched as is visible from the higher interest cost data in the RBI release. Lowering of interest rates and loosening of purse strings by banks would help revive this sector, as far as bottomline in concerned. To boost their topline, these companies will still have to depend on demand picking up in the economy.

However, the services non-IT sector will continue to feel the impact as it was largely dependent on cash economy. But other sectors in this space like banking, insurance, hotels and transport might be largely unaffected and bounce back sooner as most of the transactions had moved to the electronic medium.

Even if the government had waited for the economy to improve before announcing demonetisation, the outcome would have been more or less the same as demonetisation was meant to hit at the very foundation of the cash economy, which had found its way into all parts of the economy. By doing it in late 2016, government is probably hoping that economy would be firing on all engines by 2018, just in time for the 2019 elections.

By all accounts, it wouldn’t be a stretch to call demonetization timing a political decision.